Microcredit

“Money, says the proverb, makes Money. When you have got a little, it is often easy to get more. The great difficulty is to get that little.”


Adam Smith, Wealth of Nations, 1776.


Background.


This new concept, which is more than 40 years old, when in the 70’s of the XX century this word was used for the first time according to the economist Mohammad Yunus, even though there are much older references. In fact, Jonathan Swift, an Irish writer from the XVIII century, and famous for Gulliver’s travels, proposed the idea in the beginning of that century to help Dublin’s poor population by providing small loans.



The idea was a big success and a few organizations were created to take care of the process and the “LOAN FUND BOARD” was also developed in 1837.



According to Hollis and Sweetman in “Microfinance and Famine” (2003) one of the mentioned organizations recorded this:



  • Disbursed loans: 1649
  • Average amount: 3 pounds
  • Largest loan: 10 pounds
  • Term: 20 weeks
  • Weekly payments
  • Interest 8.8% annualized
  • Used as working capital, inventory purchase, rent and goods
  • 20% of the clients were women

The similarities with today’s industry is amazing




Definition.



Wikipedia describes Microcredits as “SMALL LOANS GIVEN TO POOR CLIENTS WHO CAN’T ACCESS TRADITIONAL BANKING”.


Another way to describe a microcredit is through the goal of each loan, as stated in Yanus Bank’s web site (Grameen Bank) where his proposal is to add labels to different kinds of loans; each microloan has a classification according to traditional, rural, agricultural, fishing and more.



But after all, Grameen describes microcredits as “PROGRAMS TO SPREAD SMALL LOANS TO POOR PEOPLE WITH SELF EMPLOYMENT PROJECTS THAT GENERATE AN INCOME TO COVER PERSONAL AND FAMILY EXPENSES”.


Therefore in my personal experience with microfinance, the microcredit concept can be “Small to medium loans given to entrepreneurs that are underserved by traditional banks, accompanied by an interest rate higher than traditional banks as a consequence of the risk, and placed into short to medium terms”.


Let’s take a look at this:



  • Amounts: small to medium
  • Given to: Entrepreneurs
  • Term: Mostly 6 to 18 month
  • Interest: Higher than regular banks

These are very much the same conditions given to the Irish in 1837



Why Microcredit?


The need of the masses, the socially responsible minorities, and the good will of some others, has historically combined to create wealth.


Based on this, it has been necessary to help those, who from their own means, produce goods and services; but to make sure those goods and services get to larger communities at a lower cost, investment is necessary.



Therefore the microfinance institutions are dedicated to provide the necessary capital for the development of personal and family businesses.



There are some historical examples in Venezuela, such as a family that began with a small amount of capital, and a lot of will, which are now known as CENTRAL MADEIRENSE. These Portuguese immigrants built a chain of supermarkets since their first convenience store and today also include some banks and insurance companies.


Microlending has also found some opposition. Some believe that the financing of microcredits can’t be profitable, so this form of lending should be done exclusively by NGO’s, or non for profit organizations. This does not support investors who are willing to risk their money by helping small business owners. This view, in reality, limits the resources and the institutions to attending just one size of the many types of small businesses.




Why a high interest?



The microcredit industry is still young, but has seen great development. Since the beginning its interest rates have been high, at short terms and under strict supervision.



That implies a high operation cost and a big administrative structure to keep very close track of the microentrepreneurs, because the community knot can be weak. Last but not least, giving small loans can be translated as a big number of loans while a traditional bank will approve just one loan with the same amount of capital.



Having this in mind it is easy to understand the reasons for the higher interest, but there are also ways to make a loan better for the clients that have displayed excellent performance. Microfinance institutions will optimize the interest depending on the client’s ability to fulfill the agreement.



The United Nations.



This subject is well considered on some levels, as in the UN, which decided that by the end of the prior millennium to pronounce 2005 the international year of Microcredit. For this launching on November 18th 2004, Kofi Annan (Secretary-general) declared:


“Microfinance has proved its value, in many countries, as a weapon against poverty and hunger. It really can change peoples’ lives for the better — especially the lives of those who need it most.


A small loan, a savings account, an affordable way to send a pay-check home, can make all the difference to a poor or low-income family. With access to microfinance, they can earn more, build up assets, and better protect themselves against unexpected set-backs and losses. They can move beyond day-to-day survival towards planning for the future. They can invest in better nutrition, housing, health, and education for their children. In short, they can break the vicious circle of poverty.



If we are to reach the Millennium Development Goals that is exactly the kind of progress we need to make.


Let us be clear: microfinance is not charity. It is a way to extend the same rights and services to low-income households that are available to everyone else. It is recognition that poor people are the solution, not the problem. It is a way to build on their ideas, energy, and vision. It is a way to grow productive enterprises, and so allow communities to prosper.


Where businesses cannot develop, countries cannot flourish. Let us use this International Year of Microcredit to put millions of families on the path to prosperity.”



Final Considerations.


“This is a big idea, an idea with vast potential. Whether we are talking about a rural area in South Asia or an inner-city in the US, microcredit is an invaluable tool in alleviating poverty. Microcredit projects can create a ripple effect- not only in lifting individuals out of poverty and moving mothers from welfare to work, but in creating jobs, promoting businesses and building capital in depressed areas.” Hilary Clinton. Microcredit Summit, Washington D.C. 1997


We must take a closer look at microfinance NGO’s and other specialized institutions that are trying to build a common strategy with governments on fighting  poverty, but always keeping in mind, to  teach the hungry how to fish instead of giving them a fish.


This is not a full research report, but the beginning of a deeper study about microfinance.



Joaquín Moreno Pampín


September 9th, 2010


Translation: Melina Santandreu